Severn Trent leaks business profits

Water group Severn Trent said that sales would fall more than expected this
year because of a drop in business usage as the recession starts to bite.

By Garry White

6:34PM GMT 27 Jan 2009

The company said that trading was in line with its expectations in all areas of its business apart from income from water meters.

Severn Trent

The main reason for the drop is lower usage by commercial customers, where consumption is recorded. The downturn has slashed demand and forced many businesses to introduce cost savings.

Severn Trent's commercial customers included the now defunct Woolworth and MFI retail chains, as well as car manufacturers such as Land Rover and Jaguar.

In the current-year to March 31, metered revenue is now expected to fall by £20m-£25m on a year-on-year basis, compared with the £12m-£15m decline the company had previously forecast.

Severn Trent supplies water to 8m people in the Midlands, taking in the cities of Nottingham and Birmingham and parts of mid-Wales. It is the UK's second-largest water company after United Utilities.

The group also gave an update on capital expenditure, which it expects to be approximately £20m lower in this year than it had indicated, with slightly lower infrastructure maintenance expenditure, at £120-£130m.

Credit Suisse noted that any cost saving achieved in operating expenditure was therefore likely to be completely offset by lower-than-expected revenues.

The broker also said it was not surprised by the metering losses. It thought that these were not important for the company's valuation because companies will have a "clawback mechanism starting from 2010."

This is when the next regulatory review will be implemented, in which the government determines the level of operating expenditure and capital expenditure.

"Overall, we think the news is negative, not just for Severn Trent but for sector sentiment," Credit Suisse added.

The broker maintained an underperform rating on the shares, although Deutsche Bank kept its buy stance.

QUESTOR SAYS: Falling commercial consumption is a sector-wide issue and there is also uncertainty because of the looming Ofwat regulatory review later this year.

The company implied that, because of the lower inflation outlook, management was expecting a harsher review from the regulator in terms of costs. This is another problem the sector may have to contend with.

However, the shares are currently yielding a chunky 6pc and this payout is worth holding on for.

Until visibility becomes clearer Questor would not advise investors put new money into the shares, which are rated as a hold.